LIC policies: To buy or not to buy?
There is only one other thing as abundant in India as Aadhar – LIC policies. If you think you don’t have an LIC policy, think again. There is a high possibility that tucked away somewhere in an old almirah is an LIC policy in your name, started by either your parents or grandparents. True to its motto, LIC policies are everywhere – “zindagi ke saath bhi, zindagi ke baad bhi” (loosely translated as “during your lifetime and beyond”).
Close to 80% of our clients have an LIC policy. Across different surveys we have held as part of our investor awareness initiatives, we have recorded this ratio as more than 70%. Sadly, the omnipresence of LICs has not contributed to building awareness of what an LIC policy really is. We explain everything you should know about an LIC policy.
What is an LIC policy?
LIC policy is a life insurance product. If you have an LIC policy in your name, you are the policyholder, and on your death, the nominee specified in the policy will receive a certain sum of money. LIC policies come in different hues and colours – so numerous that cataloguing them would make all of Wikipedia look brief, but all policies have certain basic features.
Firstly, as highlighted above, LIC is a life insurance product. On the death of the policyholder, the nominee receives a sum of money. The amount varies depending on your choice – it could be 5 lakhs, 50 lakhs, or any other amount. Secondly, every LIC policy has a tenure during which the policy is active. An LIC policy can be active for varying tenures – 10 years, 30 years, or even a policy covering the policyholder for their entire life. If the death of the policyholder occurs during this tenure, the nominee receives a sum of money from the LIC. However, if the death of the policyholder occurs beyond the tenure of the policy, there is no obligation to pay the nominee.
Thirdly, for receiving insurance on their life, the policyholder pays a premium to LIC. This premium could be paid monthly, quarterly, semi-annually, or annually. The period for which this premium is paid also differs – it could be for the entire tenure of the policy or for a shorter period. For instance, an LIC policy can be active for say 30 years, but the premium may be payable only for 10 years.
All LIC policies are some permutation or combination of the above basic features.
What else should you know?
If LIC was just a life insurance product, we could have ended here. But life is never so simple, and neither is an LIC policy. This is because apart from insurance, there is an investment component attached to LIC, and this is where things get complicated.
The premium which you pay towards your LIC policy is not only used for providing you with life insurance but is also used for investing on your behalf. Now, one would assume that since LIC is an insurance company, a large part of the premium you are paying is being used to provide you with life insurance, and perhaps only a minuscule is being used for investing on your behalf. However, the opposite is true. Let’s take an example. If you are paying INR 10,000 as an annual premium towards your LIC policy, the life insurance cover will be about INR 1 lakh (in general, the life insurance amount is ten times the annual premium). If anything happens to the policyholder during the tenure of the policy, the nominee will receive INR 1 lakh.
For providing this life insurance, LIC charges a mortality charge. This mortality charge is less than 1% of the insurance amount. So, for an insurance cover of INR 1 lakh, the mortality charge will be less than INR 1,000. So, only about 10% of your annual premium of INR 10,000 is used for providing life insurance coverage. Let’s look at what happens to the balance 90% of the premiums you pay.
There are various kinds of charges which have a brawl to stake a claim on this 90% - administration charges, service charges and sundry other charges, but the largest chunk is claimed by agent commissions. LIC pays agent commission to the individual or organisation who sold the LIC policy, and the commission on the first year’s annual premium can be as high as 35% (it comes down in the subsequent years).
After the above expenses, the balance is invested on your behalf in financial markets.
Important takeaway
Two key takeaways. One, because only a minuscule part of the premium you are paying is used for providing you with life insurance, the insurance coverage received in an LIC policy is low. The typical life insurance cover you will receive in an LIC policy is ten times the annual premium. So, even if you are paying an annual premium of INR 1 lakh, you will receive life insurance cover of INR 10 lakhs. For an average family, this is a very low amount. If something happens to the breadwinner of the family, an insurance amount of INR 10 lakhs will barely cover the family’s expenses for a few years (if at all).
Two, since such a large part of the premium you are paying (upto 35% of the first year’s premium) is being used to pay commission to the insurance agent, the return that you earn in an LIC policy is also low. Generally, the return that you earn in an LIC policy varies from 4 to 6%. Given that most LIC policies have a very long tenure (mostly above 10 years), these returns are unattractive. The typical LIC policy combines two things – life insurance and investments, and this is where the problem lies. By trying to fulfil two objectives, it does justice to neither. It fails as a life insurance product because the coverage provided is too low. It also fails as an investment product because the returns provided are paltry.
If not LIC, then what?
An important lesson for investors is not to mix insurance and investments. If you want life insurance, buy an insurance product which does just that– provide life insurance. Fortunately, such life insurance products exist, and they are called term life insurance. But since term life insurance does not have an investment component, there is less money to be made in different fees, charges, and commissions. This is why unless you explicitly request a term life cover, a typical LIC agent will not show you this product.
In a term life cover, 100% of the premiums you pay (less the expenses) are used to provide you with life insurance. Whereas non-term life insurance will give you insurance coverage of 10 times the annual premiums you pay. In a term life cover, this number can be about 300 times (depending on your age and health conditions). To put that in perspective, INR 1 lakh paid in annual premium towards a typical LIC policy will give you INR 10 lakhs of life insurance coverage, whereas INR 1 lakh annual premium paid towards a term life cover can fetch you insurance coverage of INR 3 crores. For a family which loses a breadwinner, this difference can make all the difference. A sum of INR 3 crores kept as fixed deposits at a bank will fetch the family an annual interest income of INR 21 lakhs.
I have an LIC policy, what should I do?
An LIC policy is like Hotel California – you can check in any time you want, but you can never leave. The surrender charges for prematurely closing an LIC policy are usually very high. So, if you already have an LIC policy, continue to service it, just don’t buy any more policies!
Is there anything that an LIC policy gets right?
The answer is yes. LIC is a behemoth. It manages assets valued up to USD 450 billion, which is higher than the GDP of certain countries. You may have trouble finding water, but not an LIC agent. So clearly, LIC must be doing something right.
LIC is the first (and sometimes the only) financial product that Indians invest in. In a country with a penchant for investing in gold and real estate, this is not a mean feat. The name LIC evokes trust and through this trust, it has managed to find a place in people’s savings – across strata. It has managed to divert savings from “dead assets” like real estate and gold and has used its large asset base to invest in the Indian economy. A growing economy is always hungry for capital, and LIC has played an important role in its provision. The good thing about an LIC policy is that your investment is safe. In fact, some would rate the safety of an LIC policy to be higher than bank fixed deposits. There are several precedences of bank failures but no precedence of anyone losing money in an LIC policy. For investors who fear investing and keep all their savings in fixed deposits, LIC is a better option. The interest earned in a fixed deposit is fully taxable, whereas the return earned in an LIC policy is tax-free.
LIC policies have low insurance coverage, which is still better than no insurance. The returns are low, but again, that’s better than no returns. So, parking your savings in LIC policies is better than doing nothing. However, if you can walk the extra mile by either appraising yourself better or working with a financial advisor, you can put your savings to much better use. Professional financial planning will help you get a significantly larger insurance coverage that secures the economic future of your dependents, along with earning higher returns on your savings.
Ravi Saraogi, CFA, is a SEBI Registered Investment Adviser and co-founder of www.samasthiti.in, which provides investment advisory and financial planning services.